Free Markets, Free People
James Pethokoukis reminds us that if we’re not watching the European debt crisis, we should. The one thing Tim Geithner apparently got right was how it could effect the US negatively. Geithner said:
Europe is so large and so closely integrated with the U.S. and world economies that a severe crisis in Europe could cause significant damage by undermining confidence and weakening demand.
And that’s the obvious truth. If you need to catch up, here’s an article in the Financial Times to bring you up to date (you may need to sign up or register to read it).
Pethokoukis then points to a report from Barclays Capital that details what Geithner was talking about:
Our baseline forecast assumes that policymakers will prevent the turmoil in Europe from leading to a full-blown financial crisis similar to 2008 and that US policymakers will not impose excessive fiscal tightening starting in 2012. If, by contrast, either of these risks is realized, the potential for another recession will increase substantially. We use the Fed’s stress scenario under the Comprehensive Capital Analysis and Review (CCAR) as an alternative scenario to our baseline, but ratchet up the intensity modestly and analyze its effect on the outlook for house prices.
1) Our modeling suggests that in a recession scenario, house prices, as measured by the CoreLogic headline index, could decline another 7% in 2012 . … The scenario posits declining real GDP for four consecutive quarters, with Q2 12 having the deepest decline at 6% (q/q saar).
2) Real disposable personal income also declines for four consecutive quarters, albeit with a one-quarter lag relative to the decline in GDP, and the unemployment rate moves persistently higher, peaking at 12.1% by the end of our forecast horizon. …
3) Furthermore, the rising unemployment rate suggests that delinquencies would push shadow inventory higher, putting downward pressure on distressed home prices. Together, the two effects send home prices significantly lower in 2012.
Or in simple terms, if Europe goes, so does the US. Housing down another 7% and unemployment up into the 12% area.
Obviously this is all based on modeling and plugging in various numbers. So just as obviously those numbers could be off a bit. However, the basic premise is correct. If Europe can’t solve its debt crisis, the US will also suffer and, as you can see, suffer mightily (check out the chart at the link).
I think the political implications are clear even for the most partisan among us.
As expected global market reaction to the US credit downgrade has been anything but positive.
Global stock markets sank again Monday as worries over the downgrade of U.S. debt outweighed relief at a European Central Bank pledge to buy up Italian and Spanish bonds to help the two countries avoid devastating defaults.
European markets shed their early momentum and losses were heavy in Asia. Most stocks were trading sharply lower amid mounting fears over the opening of U.S. markets, when traders will have their first chance to respond to Standard & Poor’s momentous decision to lower its triple A rating for the U.S.
"The reverberations from S&P’s downgrade are still being felt across the globe," said David Jones, chief market strategist at IG Index.
The European Central Bank’s buy of Italian and Spanish bonds – two Euro countries in deep financial trouble – at first seemed to allay the expected downturn. However that was later reversed and global markets saw a sharp downturn.
At this time one can only speculate what will happen in US markets, but the global sell off is not a good sign.
Monday’s trading came after one of the worst market weeks since the collapse of U.S. investment bank Lehman Brothers in 2008 – around $2.5 trillion was wiped off global stocks last week.
In Europe, Britain’s FTSE 100 index of leading British shares was down 1.7 percent at 5,157 while France’s CAC-40 fell 1.6 percent to 3,227. Germany’s DAX was 2.3 percent lower at 6,091.
Sentiment in Europe was hurt by an expected sell-off at the U.S. open – Dow futures were down 1.8 percent at 11,196 while the broader Standard & Poor’s 500 futures fell 2.1 percent to 1,173.
The one bright spot in an otherwise dismal picture is the US Treasuries market. And “bright spot” is a relative term considering the rest of the markets:
So far, the S&P downgrade doesn’t seem to be having too much of an impact on U.S. government bonds, known as Treasuries. The worry has been that the downgrade would prompt investors to demand more, but the yield on ten-year Treasuries has actually fallen.
"Early market reactions suggest that the treasury market will remain well supported," said Jane Foley, an analyst at Rabobank International. "Even though there may be no sharp sell-off in treasuries this week, S&P’s decision should at least provide a signal to the U.S. government that it may be foolhardy to continue to take its creditors for granted indefinitely."
Two points. One – yes, it should provide such a signal. However, if that signal isn’t acted upon and acted upon swiftly, then two – the treasury market will not remain well supported. Interest rates will rise on demand by investors and servicing our debt will cost more and more.
To add more fuel to the fire, there’s this:
"Investors are concerned about a rising risk of global recession, credit downgrades especially now in the eurozone, such as France, the threat of a major bank bust and a global liquidity trap as investors stay in cash," said Neil MacKinnon, global macro strategist at VTB Capital.
So much to watch and consider. While this may not be the most interesting news to read about, none is more vital. The problems in both Europe and the US have a far reaching effect on global markets. And they will have an effect, at some point, on everyone’s wallet. We’re in uncharted territory here, and unfortunately, there are no easy and painless ways to solve these problems.